The government introduced into the House of Representatives the Treasury Laws Amendment (2017 Measures No 2) Bill 2017 on 25 May 2017. The Bill implements various changes to the new superannuation regime. One of these relates to transition to retirement income streams (TRISs) and the recipient meeting certain conditions of release. The purpose of this article is to outline how these changes will impact on self managed superannuation funds (SMSFs) continuing to pay TRISs after 30 June 2017, and some of the traps associated with these changes.

As is widely appreciated, super funds after 30 June 2017 will no longer be exempt from tax in relation to the payment of TRISs, meaning broadly that earnings on assets supporting a TRIS will be taxed at the accumulation rate of 15% (or possibly 10% for capital gains). The government proposes to introduce changes to the law to make it easier for super funds, including SMSFs, to be exempt from tax if the recipient meets certain conditions of release in respect of their TRIS. The relevant conditions of release are (only one must be satisfied):

retirement

terminal medical condition

permanent incapacity

attaining age 65.

According to the explanatory memorandum that accompanied the Bill (para 1.131), a superannuation income stream that is established as a TRIS will always retain its character as a TRIS. On this view, the changes to the law mean that earnings from assets supporting TRISs will no longer be exempt from tax after 30 June 2017, even after a condition of release is satisfied.

The explanatory memorandum goes on to state (para 1.131) that a person who wants the fund to be exempt in relation to a TRIS would need to commute and roll over their TRIS to a replacement superannuation income stream, such as an account-based pension. To avoid individuals having to do this, the Bill proposes to amend the law (para 1.132 of the explanatory memorandum) to make life easier for recipients of TRISs and the super funds paying them.

As the Bill is drafted, when a person reaches the age of 65, a TRIS will automatically enter the retirement phase. No notification to the fund is required. In relation to the other conditions of release mentioned above, the TRIS will enter the retirement phase only when the fund is notified by the recipient of meeting the condition of release.

These changes were originally contained in an exposure draft Bill and explanatory memorandum. In the exposure draft Bill, it was proposed that simply meeting one of the relevant conditions of release would mean that the TRIS would enter the retirement phase automatically. This would not have required any notification to the fund for meeting the conditions of release of retirement, terminal medical condition or permanent incapacity.

This change from the exposure draft should make it easier for super funds to know when the TRIS will enter the retirement phase (subject to special issues relating to SMSFs discussed below). However, the notification requirement will potentially delay the time from when the exemption will apply for relevant conditions of release other than attaining age 65.

An impact of the change is that at the relevant time (ie turning 65 or the notification for the other relevant conditions of release) the transfer balance cap rules will apply. There will be a credit to the recipient’s transfer balance account equal to the value of the account balance supporting the TRIS at the relevant time (ie turning 65 or notification for the other relevant conditions of release). If the account balance is more than $1.6m (assuming that there are no other pensions that have led to a credit to the recipient’s transfer balance account), then the recipient will exceed their cap. This can then lead to excess transfer balance tax, and an excess transfer balance determination and commutation authority from the ATO. The difficulty faced by SMSFs and their advisers is the relevant time may occur before anyone turns their mind to the situation, particularly in the instance where the TRIS enters the “retirement” phase automatically.

A particular issue for SMSFs is when a recipient of a TRIS meets the “retirement” condition of release and doesn’t make a notification in writing. For example, if the recipient is 60 or over, “retirement” includes an arrangement under which the member was gainfully employed comes to an end (reg 6.01(7) of the Superannuation Industry (Supervision) Regulations 1994 (SISR). There is no need for the trustee of the fund to be satisfied that the person never intends to be gainfully employed again. Gainful employment is defined to mean employed or self-employed for gain or reward in any business, trade, profession, vocation, calling, occupation or employment (reg 1.03 SISR).

The following are examples of what would be retirement for a person aged 60 or over, even though the person may not in any way feel that they have retired:

a partner in a law or accounting firm who is a university lecturer on a permanent part-time basis terminates that employment

a person who is employed by three entities in a group terminates employment with one entity (eg that entity is wound up)

a self-employed person (eg a sole trader) incorporates the business and becomes an employee of the company taking over the business.

However, retirement on its own is not sufficient for the TRIS to enter the retirement phase. The recipient must also notify the fund. It is unclear how this notification requirement will be satisfied in respect of SMSFs. The person who has “retired” will know what has happened, even if they do not know that they have met the condition of release of retirement. They will be a trustee or director of the corporate trustee, perhaps even the sole director. Will this knowledge, without more, be the requisite notification? There is no requirement in the Bill that the notification must be in writing. If the ATO considers the member has satisfied the condition of release and implicitly provided the notification, the adverse transfer balance consequences outlined above may arise.

Hopefully, the ATO will apply the change in a reasonable manner and would not impose the various consequences of exceeding a person’s transfer balance cap if they “retire” and are a member of an SMSF, but the trustee of the fund doesn’t apply the cap rules until the person gives actual written notification to the trustee.

For TRISs that will continue after 30 June 2017, it would be worthwhile reviewing before 30 June:

whether any conditions of release may be satisfied, which may allow the TRIS to convert to an account-based pension, maintaining tax-exempt status before the new changes take effect

the terms of the TRISs to see whether they are inconsistent with the new law and, if so, amending the terms to make them consistent. Based on the drafting of the Bill, it does not appear to be possible for the terms of a TRIS to override the “auto rule” (eg have provisions that provide that the TRIS does not enter into the retirement phase).

Advisers with funds that continue to pay TRISs after 30 June where the recipient may have a relevant pension balance above $1.6m should carefully consider the circumstances when the recipient is about to turn 65, or may “retire” before then. Those funds will require additional care.

Also, because a super fund cannot be exempt from tax in relation to a TRIS until the recipient “notifies” the fund of meeting certain conditions of release, such as retirement, the recipient should advise the trustee as soon as possible after meeting the relevant condition of release. So, for example, if a recipient retires in July 2017 (under the age of 65) but does nothing and the adviser does not find out about it until, say, March 2019 when the tax return is being done for the fund, the fund cannot be exempt from tax in relation to the TRIS until March 2019, when the adviser arranges for the recipient to notify the fund (assuming the recipient is still under the age of 65).